Dollar up as producer prices rise by more than expected
CPI numbers and Fed decision the greenback’s next tests
Wall Street ends Friday session in the red
ECB and BoE on the agenda as well
Dollar rebounds after upside surprise in PPI data
The US dollar entered the new week on a strong footing, outperforming most of the other major currencies. Perhaps market participants decided to enter some long positions, or liquidate some shorts, after Friday’s data showed that US producer prices slowed by less than expected in November, which tilts the risks surrounding Tuesday’s CPI numbers to the upside.
A smaller-than-expected slowdown in consumer prices may prompt market participants to revise up the level at which they expect interest rates in the US to peak, but they are unlikely to alter their expectations with regards to nearly two quarter-point cuts by the end of 2023. After all, the University of Michigan 1-year inflation expectations index slid to its lowest since September 2021.
Investors may prefer to wait for the Fed decision and the updated ‘dot plot’ on Wednesday before they reevaluate that assessment. A median dot for 2023 near the market’s terminal level would suggest that policymakers are sticking to their view of a prolonged pause after they are done raising rates, which could prove supportive for the US dollar.
On the other hand, a median dot below the market’s peak could mean two things: either that interest rates are expected to peak at a lower level or that they may be taken higher but be cut towards the end of the year. This would likely add credence to the current market hypothesis and may result in another leg south in the greenback, even if the currency receives some support from the CPI data a day earlier.
Wall Street slides as investors lock gaze on Fed
Wall Street ended Friday’s session in the red as the smaller-than-expected slowdown in producer prices revived concerns of stickier inflation, and thereby higher borrowing costs for longer.
Market participants may continue to reduce their risk exposure in case consumer prices confirm the picture painted by the PPI indices, but they may be willing to buy again in case the Fed’s dot plot enhances the narrative of lower interest rates towards the end of 2023.
Having said all that though, even with rate-cut expectations staying firmly on the table, equities could well resume their prevailing downtrends in case economic data continue to come on the weak side. Yes, poor numbers seem supportive for now as they reinforce the notion of lower interest rates, but deeper wounds could very well break that correlation as a damaged economy is anything but positive for the earnings outlook.
ECB and BoE also on tap
This week’s central bank chorus will not end on Wednesday with the Fed decision. On Thursday, the central bank torch will be passed to the ECB and the BoE.
Following the larger-than-expected slowdown in euro area inflation for November, investors scaled back their bets of another triple hike by the ECB, and they are now more convinced that a 50bps increment may be appropriate. Although the updated macroeconomic projections are a downside risk for the euro, as they could point to a recession in 2023, a hawkish message and even a split Council with some members favoring a larger hike could prove supportive for the euro.
Ahead of the November inflation data, ECB President Christine Lagarde said that inflation has not peaked, while chief economist Philip Lane more recently said that they will have to raise rates several more times, remarks which add some credence to the hawkish case. After all, headline inflation remains in double digits, which doesn’t allow room for complacency.
The BoE is also expected to proceed with a 50bps hike, with investors currently assigning nearly a 70% probability for such an action. This will be one of the smaller meetings that are not accompanied by updated economic projections nor a press conference and thus, any market reaction may come from the statement. According to market pricing, investors believe that this Bank still has a lot of hikes left in its chamber, and thus, anything pointing in the opposite direction may weigh heavily on the pound.
Nonetheless, with the Bank forecasting a prolonged recession, pound traders may pay more attention to important UK economic releases that are due to be released ahead of the decision, like the employment report on Tuesday and the inflation numbers on Wednesday.